The CBI’s strange position on NEST charging

Earlier this week the CBI published a brief saying that the proposed charging structure for NEST pensions would put people off joining.

I’m genuinely puzzled by why the CBI published this. Not only are its arguments flawed, but I do not see what purpose it serves.

But first here is a little background. NEST is the body set up by government to provide low cost pensions to employers who do not choose another pensions suppliers once the duty on employers to auto-enrol their staff and then contribute to their pensions starts in 2012.

While independent of government, it has a very definite public policy purpose and mission set by the various recent Pensions Acts. Its duty to be the default provider of pensions means that it has a public service obligation to accept any employer however small, disorganised or expensive to service. It will be the only pension provider that is both limited in the contributions it can receive (with a maximum annual contribution) and forbidden to accept transfers in or out. It has a mandate to target low to moderate earners who have been comprehensively failed by the existing pensions industry.

But although it has these limitations and public duties it is expected to be entirely self-financing. The Pensions industry lobbied hard to ensure this – much of which is made up of CBI members. They had the support of the Conservatives, and there may be EU state aid issues as well.

That means that NEST needs to borrow money to set itself up and repay the loan from charges to its savers.

The traditional way of charging for pensions is through an Annual Management Charge (AMC). This takes a percentage from each person’s pension pot every year. To give an example stakeholder pensions that were set up in the early years of the Labour government as a low-cost product are capped at 1.5% for the first ten years and 1% thereafter.

The target charge for personal accounts (which is what NEST pensions were once called) in the Turner Commission report was 0.3 per cent AMC.

But NEST has a particular problem in raising funds from an AMC. Initially funds will come in very slowly as contributions are being both phased and staged. The pre-budget report extended this by a year so that full contributions will not be paid until 2016. There will be a good few years when only some employers and employees are paying only one per of their earnings.

An AMC of 0.3% of not very much raises diddly squat, leaving NEST highly leveraged and landing ASMC payers with a high borrowing costs. The decision was therefore made to add to a 0.3% AMC a 2% contribution charge in NEST’s first 20 or so years. This has the advantage of raising more money in the early years as a contribution charge does not depend on funds building up within NEST.

This means that early savers will be charged 2% of their contributions plus 0.5% of their pensions pot each year. However it should not be forgotten that the state will also be paying tax relief into the pension pot. When contributions have built up to their full amount employees will pay 4%, employers 3% and the state will pay 1% of a band of earnings. The state is therefore paying 12.5% (one eighth) of total contributions.

You can’t simply work out what the dual charge would be is it was changed into just an AMC as it will vary over time, but on average it is probably around 0.5% to 0.6% – more for short-term savers, less for long-termers.

The CBI’s case is that:

The Government’s new workplace pension scheme could deter millions of savers because of its high and complicated charges…

Businesses are worried that staff, and particularly the lower paid, will baulk at the proposed charging structure of the National Employment Savings Trust (Nest), which loads fees towards the earlier years after a pension is opened.

And in the brief they say:

Low cost private schemes will deliver better value for money for a long time

I think these claims are nonsense – and worse – the CBI do not say what should be done instead, which does seem to be a basic duty on players in public policy debates (though I am sure there are examples where we have just whinged too!)

First I do not think that anything other than a tiny minority of savers understand the charging structure of pensions, so the idea that a dual charge in itself will deter seems to me to be very contentious.

Second, it is misleading to say that NEST savers could easily find better value. NEST pensions are inevitably going to be mainly taken up by small employers and the low paid. This is precisely the group that the pensions industry does not serve – it’s the market failure that led to the wide consensus for setting up NEST in the first place. The best this group can get are stakeholder pensions – and they start with a 1.5% charge.

I am not the only person puzzled by this stand. Here is the much quoted Tom McPhail of the mega-IFA Hargreaves Lansdown, who is not always on the same side of arguments as the TUC.

Hargreaves Lansdown head of pensions research McPhail accused the CBI of being divorced from reality – arguing that the average scheme member had “precious little understanding” of the minutiae of pension charges.

He also hit out at the business representatives claim that NEST was poor value compared with “a pension with significantly lower average charges”.

“Let’s ignore for a moment the logical absurdity of making such a statement and consider where investors are supposed to find such a pension? If such an option does exist, then it is keeping a remarkably low profile.

“By comparison with NEST, stakeholder is obscenely expensive. The people NEST is designed for are not currently being offered a low cost, top of the range company pension scheme – in fact most of the time they aren’t being offered anything at all. Even with the 2% initial charge, NEST works out at the equivalent of 0.5% per annum and that is very good value.”

And what would the alternative be?

There is a strong case for paying at least some of NEST’s start-up costs from taxation because it is serving a public policy purpose and because its ability to compete with existing pensions schemes has been hobbled by industry lobbying. But I doubt that this is the CBI’s position. It certainly wasn’t when the legislation was going through parliament.

I suppose we could have had a higher AMC but that would mean that NEST’s borrowings would be higher for longer – and that would not help the deficit, which the CBI is keen to see come down quickly.

While I am critical of this particular CBI initiative, it is right to say that they did get the much bigger question right.

Their support for auto-enrolment and a compulsory employer contribution was crucial to making the 2012 settlement a reality. And while we have not always agreed about the detail of implementation there is a strong core of agreement between the TUC and CBI on making 2012 work. This has led to some constructive give and take on both sides as plans have become reality – some real social partnership you might say – and I am sure that spirit can survive this issue as there are other issues where social partnership needs to work for pensions – such as improving DC.

Written by Nigel Stanley

I was the TUC’s Head of Campaigns and Communications until semi-retiring in May 2015, I started at the TUC in 1994.
My interests cover a wide range of communications and politics related issues, but if I have a specialist subject, it's pensions…

A couple of points in the spirit of open debate. As you know we are as keen as you are for this whole thing to work.

As pensions people, we talk pensions all the time, but ordinary (dare I say it, normal, people) don’t. Come 2012 we are relying on inertia to get people who have never saved to save. We shouldn’t underestimate people’s hostility to pensions, and if a Mirror Money can right up “dont stick your money in Nest, they take 2.3% off you in year one”, there may be a stampede out – despite the employer contribution and tax relief.

Secondly, remember not to confuse the employer duties (auto-opt-in and employer contribution) with the NEST scheme itself. You can have one without the other. For almost all employers, this charge means their staff will be better off in GPPs than NEST (most firms of 50 or more folk can already get 0.6, which will be lower than NEST charge rate for longer than the average tenure in a job). Fine for providers – and that’s important – but what if that means NEST doesn’t have the big numbers it needs to run at 0.3? What then for the people the insurance industry really can’t reach?

Finally, let’s not confuse a loan (on teh balance sheet) with spending (in the P&L). I know government accounting does this, but do we have to let flawed accounting drive policy?

Thanks Neil for responding (By the way, in case anyone outside the rarefied pensions world doesn’t know, Neil’s the author of the CBI document.)

First, I don’t question the CBI’s commitment to getting this to work, that’s why I thought this paper was a bit odd as it somewhat plays into the hands of those who don’t.

I think it’s more likely to be the Mail that runs that kind of story, but it’s easy to rebut.

If I’ve understood the staging and phasing properly – in the first year of the scheme for every pound an employee puts in, the employer will put another pound and the state will put 25p. So for every pound the employee saves, they get another 1.25 on top.

Once the phasing and staging has worked its way through we reach the final rates of a 4 per cent employee contribution, 3 per cent from the employer and 1 per cent tax relief.

For every pound an employee saves they will then get an extra 75p from the employer and 25p from the state. In other words buy one pound of pension and get one free.

As I’m not entirely sure I’m right about how the gearing works in the first year of phasing let’s use the mature rates to look at charges.

Neil gives 2.3 per cent as the charge in the first year. 2.3 per cent of £2 is 4.6p. So more accurately to take account of charges we should say that for every pound of pension you save you get an extra 95.4p free.

That’s still a pretty good bargain. I’m confident with that argument.

You are no doubt right that there are big employer sponsored DC schemes with charges not that far away from NEST’s notional AMC. But as Tom McPhail argues, the big bulk of employees who will end up in NEST won’t be able to join such schemes.

I worry that NEST might not get enough savers too, but I don’t think the charging structure is the problem. I worry more that the restrictions on NEST such as the upper limit and prohibitions on transfers mean that it is not a product likely to serve all the staff of a business. This will make it a hard sell in some sectors.

As you argue that NEST charges now make it uncompetitive with GPPs, the rationale for these restrictions – imposed after lobbying from the industry – has evaporated.

I’m entirely with you on daft accounting assumptions by the Treasury, but the realpolitik suggests that we are not going to get them changed.

(After all the whole PFI approach is based on getting debt off the state’s balance sheet onto somebody else’s for equally daft accounting reasons.)

But while I can see the argument for a pure AMC under a more relaxed HMT regime, I don’t think it would make much difference to recruitment rates.

One could argue that the contribution charge element benefits the young – the most difficult to recruit into pensions – but I wouldn’t. I just don’t think charging makes that much of a difference.

The real value of the charge is not really the issue, it’s the perceived value. This text from the PADA focus group work with potential scheme members chilled me: “Across the sample, the combined AMC and contribution charge was viewed negatively, by almost all respondents, on two fronts. First, respondents found it too difficult to understand two different charging structures at the same time and in combination with each other. Second, respondents could not see a clear rationale for there being two charges instead of one and were suspicious that it would be a way to take more money ”by the back door”.”

In a sense, I am not arguing about the charge level so much as how it makes people feel when the Daily Mail (if it is thus) runs the story about it. Why put that hurdle in the way? An AMC reduced over time would be equally effective.

Let’s be clear here – nothing we are saying questions the need to do this. We just think that with a lower contribution charge you take away a hurdle that might trip the thing up.

Perhaps, if the CBI is concerned about this, it could offer to solve the problem by advocating a small increase in the employer’s contribution rate for the first 20 years of NEST. Taking the full rates, the employer’s contribution would need to be 3.16% rather than 3.00% to put savers back where they were before the 2% contribution charge.

I’ve read the focus group reports too – I seem to remember that they preferred a contribution charge over an AMC.

Indeed the TUC was about the only body that suggested a contribution charge in our submission to NEST. This was partly because of the focus groups, partly because it is easy to understand, partly because it favours the young and partly cos it’s fun to take contrary positions occasionally.

But we were clear that the form the charges take is a second order issue compared to keeping them as low as possible.

You may be right that dual charges will confuse some, but if the Daily Mail want to run anti-NEST pieces and they already have, they won’t let the facts get in the way of a good story.

But you are right that there aren’t huge issues of principle here between us, and it may be that at least some small section of Touchstone’s modest readership now know more about pensions charging sructures.